On Firm Ground..?

Have insurers finally found their “financial feet”? Initial industry financial data revealed by the Insurance Bureau of Canada (IBC) at Swiss Reinsurance Co. Canada’s recently held “Statistical Breakfast” seminar suggests at dramatic improvement in underwriting across most lines of business for the 2003 financial year with most of the top-ranked companies showing healthy profitability.

From an overall industry perspective, two key performance ratios – return on equity (ROE) and the combined ratio – indicate that insurers have indeed found their feet. Insurers ended 2003 with an average ROE of 10.7% (which is in line with the Canadian industry’s long-term performance trend) while the combined ratio dipped through the all-important 100% breakeven level to reach 98.7% – compare this with 2002’s dismal 106.5% ratio. Notably, the top 25% ranking of companies brought home an average ROE of 26%. Insurers also saw their first positive reserve development for 2003, presumably ending a streak of large adverse reserving adjustments that became characteristic of the immediate preceding years.

On the revenue side, insurers’ enjoyed a 24% year-on-year increase in net earned premiums for 2003, which follows on the back of a 20% gain made for 2002. Two years of such growth in premium is unprecedented, observes the IBC’s chief economist Jane Voll (see MarketWatch of this issue for further details on the industry’s 2003 results). The strong revenue growth achieved over the past two years has catapulted property and casualty insurers into a $35 billion industry from its average size of around $18-$19 billion during the1990s, says Paul Kovacs, president of the Property and Casualty Insurance Compensation Corp. (PACICC), and the former chief economist at the IBC. Based on this revenue growth trend, the industry will likely rise to about $40 billion in annual revenue by the end of 2004, he adds.

That was the good news. At best, the latest industry financial results show that insurers are healing their wounds, but that the “scar tissue” remains vulnerable. Highlighting the precarious position of the industry is the fact that the lower 25% ranked companies ended 2003 with a negative ROE of 5%, with the range of combined ratios reported by all insurers coming in at a low 90% to reach an alarming 150%-plus.

And, when it comes to my favorite “kicking horse” – reserve adequacy – the jury is still very much out to whether insurers have crossed into safe territory. Notably, reserve adequacy remains a prime concern of federal regulator, the Office of the Superintendent of Financial Institutions (OSFI) and the rating agencies who are still issuing more company financial downgrades than upgrades. Although, the rating agencies have indicated that many of the downgrades issued relate not only to capital adequacy but also the prospect (or lack thereof) of sustainable profitability, observes Ann Godbehere, chief financial officer of Swiss Reinsurance Co. (Godbehere was a guest speaker at the Statistical Breakfast event).

Even though insurers managed to achieve a positive reserve development for 2003 (which is a critical component for long-term capital sustenance and business growth), a worrying factor disclosed by Kovacs is that reinsurance recoverables now account for about 70% of the industry’s equity – double the level of the past. Kovacs says further analysis of this data is needed to determine what impact or implication the reinsurance recoverability issue might hold for insurers.

However, Standard & Poor’s (S&P) has expressed concern over the heavy reliance of U.S. insurers on reinsurance recoverables in terms of their reserving positions, and whether reinsurers will be amicable to these charges in the event of claims (the rating agency has also questioned the disproportionately lower reserve adjustments made by reinsurance companies over the past year relative to the actions taken by primary companies, and therefore whether some reinsurers will be able to honor claim commitments). As such, S&P predicts an increase in legal disputes between insurers and reinsurers over claim payments in the year ahead.

Reserve adequacy aside, insurers still face a formidable challenge regarding the mandatory auto line, which Voll says produced a combined ratio of more than 100% for 2003 – despite the hefty price adjustments made by companies. And, there remains uncertainty to how beneficial the legislative auto insurance reform measures being implemented by the various provinces will be in bringing down claims costs, Voll notes. The increased political attention on auto has resulted in a more trying regulatory burden which will add pressure on insurers’ operating costs, she adds.

Another doubtful factor is how long insurers can maintain double-digit growth in premium income (particularly in the order of 25%-plus) before the various political forces cry out against abusive practices by the big, bad insurance companies. Clearly, the key to sustainable growth of the Canadian p&c insurance industry means getting claims cost inflation below the double-digit level.